September 18, 2007

The fair, equitable, and just price of music is $0. And when I say this I don’t mean that this is the price that I would like to see music sell for, or should sell for, in an ethical sense; it is the price that music would sell for in a completely free market. If we work under the assumption that the prices that free markets decide on for products are desirable (perhaps because of their efficiency) then we must agree that the best price for music is $0, and that any higher price is a sign of inefficiency, at the very least.

The reason that music doesn’t cost $0 is because of monopolies. Although the record companies are one kind of monopoly the monopolies I have in mind here are the bands themselves. Consumers don’t want to buy music in general, they want to buy the music of specific groups. If you want to listen to Elvis you aren’t going to go buy a Crüxshadows CD, even if the second is much cheaper than the first. Most bands then aren’t really in competition with each other, and thus will, if left to their own devices, price their music so as to maximize profits, which usually means more than the price that their music would sell for in a perfectly “fair” scenario (one in which producers don’t have an advantage over consumers).

To see what the fair price of music is we need to envision a situation where these monopolies don’t exist. For example, bands could be forbidden from distributing their own music, and would instead have to sell the rights to distribution. And the band will, of course, try to sell these rights to as many people as possible, in order to make more money (again, assuming we forbid exclusive contracts). And now we have a situation where markets can work, where comparable products (in this case the same music) can compete with each other. In such a situation the price of music will tend towards the cost of distribution. Even though the distributors may have to pay a substantial up-front cost they will try to make that back by selling as many copies as possible, selling each at only slightly over the cost of production, and making that money back simply by selling in large volume. Now in the days of CDs this would have been the production cost of the CD plus a few cents for overhead. However, now that we can distribute music digitally, the cost of distribution is $0. Even bandwidth costs can be effectively passed onto the consumer by distributing music via peer-to-peer software. And instead of needing to add a few cents to the cost of distribution to cover overhead that money could easily be made using advertising instead. Even without the internet I expect most music would still be able to had for free, companies would buy the rights to distribution, but instead of trying to sell the music on its own they might throw it in with another product as an added bonus or give it away as a promotion, in order to increase sales of the more expensive item.

In fact music is just one example of how vertical integration can disrupt the operation of free markets. A more common occurrence of this phenomenon is brand loyalty, where customers buy a product because it is a brand they have bought before or because they have been exposed to advertising promoting it. Brands also inhibit the competition that leads to the best price, because when brand loyalty is factored into the equation it may not be enough to sell your product for less than your competitor. Instead you may need to invest more in advertising in order to convince more people to buy your product, which a reduction in cost could not accomplish. But you can only spend so much, effectively, on advertising. Since cutting prices doesn’t help substantially this means that most products end up costing more than they should, which means that profits might exist. And profits (economic, not accounting) are the greatest evil, not because money is bad, but because their existence is a sign that the free market isn’t working as efficiently as it can. In an ideal world the owner shouldn’t make much more than their employees, because the existence of profit means that they should reduce the cost of their products or invest more money in improving them; even if they don’t their competitors might, and then in the long run they will end up making much less money. Thus the existence of profits means that competition is not as fierce as it could be, and that consumers are losing out.

But we could do the same thing with brands as I supposed that we could do with music, namely disconnect the brand from distribution. Instead of one company that both produces a product and owns a brand we would have two, one that owns the brand and runs the associated marketing campaigns, and another that performs the actual production and sets prices. The brand-owning companies would sell the right to use their brand to companies whose products meet certain standards (so that if your marketing campaign is associating your brand with high quality or low cost goods the production company won’t inadvertently sabotage your efforts by putting it on a different kind of product). As with music this would introduce competition where none previously existed, because more than one company will end up competing to sell the same band of product. And thus brand loyalty and advertising would no longer stifle competition and drive prices away from those that a perfectly free market would decide on.

I could go on, but I think I have diverged enough from my initial topic. Let me conclude then simply by observing that capitalism and free markets can only work when genuine competition exists, which requires multiple companies selling products which are basically interchangeable. Thus vertical integration, in the case when a basically unique product is created for the use of a single company, such as the music of a band, a brand, or an idiosyncratic API, for starters, then competition is stifled and free markets simply can’t work the way they should, even when no explicitly competition stifling monopolies exist.